Share Capital: Don't Lose Control

Share Capital: Don't Lose Control

written by

Kirsty Simmonds

24th January 2018

Share Capital: Don't Lose Control

When you incorporated your company, you probably held 100% (or close to it) of the share capital and thought no more of it. Moreover, that share capital was probably made up of only one class of shares; ordinary shares.

However, as you look to grow your company, and if you choose equity investment as the means of doing so, you will almost certainly have to allot new shares. It might be that keeping the share capital as ordinary shares is best and there is something to be said for simplicity. Alternatively, you may wish to consider different types of share classes for your investors, or maybe your investors will require a different share class, such as:

A different class of ordinary shares - for example, perhaps the founder(s) have A ordinary shares and the investors have B ordinary shares. This allows you to differentiate between the two types of share class and the rights that attach to them.

Preference Shares - shares that will generally rank ahead of other shares in respect of declaring dividends and/or distributing capital and therefore will receive such sums prior to holders of other share types.

Each of these classes of shares can have further rights attached to them or their usual rights (the right to vote, the right to receive an income (i.e. a dividend) or the right to a return of capital (i.e. receipt of funds on a winding up) varied to suit the needs of the business.

If you’re creating different share classes, you must amend your articles of association appropriately, or adopt entirely new ones. If you have adopted model articles (as most companies do on incorporation) as they do not make provision for more than one share class.

The key factor to be aware of when allocating new shares that have voting rights attached to them is that you will be losing some level of control in your business. The key share percentages to be aware of are 75%, more than 50% and more than 25%. If you allot new shares in your company to investors by which your shareholding percentage falls below each of these levels you will lose the ability to unanimously undertake certain actions and thereby lose a level of control of your company.

Super / Special Majority

If you hold a percentage of the voting shares in your company that is equal to or in excess of 75% you will have the ability to pass special resolutions under which you can do almost anything that you would like to do with your company, some of which include:

amending the company’s articles of association;

changing the company’s name; and

dis-applying pre-emption rights (the right of first refusal existing shareholders have over any new issue of shares).

In reality, most savvy investors who are providing a substantial investment will not be comfortable with you retaining 75% or more of your company’s share capital due to their inability to prevent any of the above (unless they have additional contractual protections put in place). Accordingly, you should be prepared that you may either be asked give up in excess of 25% or accept contractual restrictions that prevent you from exercising these resolutions.

Simple Majority

Should you hold a percentage of the voting shares in your company that constitutes over 50% of the shares (a simple majority) you will hold the power to pass ordinary resolutions and can thereby undertake any of the following:

authorising sub-division or consolidations of shares, reconversion of stock into shares or redenomination of share capital; and

authorising an off-market share buyback contract.

Whilst you may be comfortable falling below the 75% threshold, you should be significantly more cautious of dropping below holding a simple majority. Not only will you be prevented from passing any ordinary resolutions should your shareholding fall below 50%, you also lose basic control of your company as the other shareholder(s) will be able to do so against your will. Alternatively, if you are left in a position where you and the investor are left in a state of 50:50 deadlock, your company may grind to halt due to the absence of a majority interest to push through any resolutions.

Minority Interests

As long as you hold in excess of 25% of the voting rights you (or the investor, should they hold such a shareholding) will be able to block any special resolutions and therefore prevent any dramatic changes to your company.

Shareholder Agreements

Away from statutory limits and requirements, a more sophisticated investor will almost certainly require you (and any other shareholders) to enter into a shareholders agreement that will govern the relationship between you by creating contractual limits and requirements that will ultimately protect that investor. Specifically, shareholder agreements will often restrict matters such as the allotment and transfer of shares and the appointment and removal of directors without a certain percentage of shareholders being in agreement. Nevertheless, whilst such agreements can seem rather restrictive you should not be too alarmed as they are fairly commonplace, albeit a poorly drafted one can cause significant governance issues.

If you have any queries in respect of your company’s share capital please contact Kirsty Simmonds or you can give us a call on 0345 070 6000.